Sunday, April 15, 2007

A Sub Prime Bail Out? Hell, No!

CNN reported on Friday that an effort may be brewing to bail out consumers who are at risk of defaulting on their sub-prime mortgages. An excerpt from this story:

On Wednesday, Congressional Democrats led by Charles Schumer (D-N.Y.) advocated steering hundreds of millions of dollars into nonprofits to help the growing number of homeowners who are having trouble paying their mortgage. But economists and industry experts say the cost of a bailout would be significantly more than that.

Christopher Cagan, director of research at First American CoreLogic, says rising mortgage payments on adjustable rate loans will force 1.1 million homeowners into foreclosure over the next 6 years. He estimates the cost of paying off the debt for those borrowers would be $120 billion.

Quite frankly, I don't care if the cost of the proposed bail out is $1 or $120 billion, a bail-out of this nature is not only bad economic policy it is also morally bankrupt.

First the moral argument: a government bail-out of the sub-prime market is a form of regressive and oppressive tax. I don't own a home. I am a renter. There are millions of us around the country. Some rent by choice (myself included), but many rent because they cannot afford to buy a house. By bailing out the sub-prime lenders and borrowers, the government would be taking hard earned tax dollars paid by renters, and giving those assets to generally wealthier financial institutions and home owners.

Second, by bailing out sub-prime borrowers the government would be rewarding financial recklessness. For years people have been talking about a real-estate bubble, but sub-prime lenders and borrowers chose not to listen. They chose to try to ride the wave to real-estate riches. If they had succeeded, those of us who chose to remain fiscally prudent and not buy real estate beyond our means, would have gotten nothing. However, now that the reckless real-estate bet failed we must share in the financial burden? Why?

Now for the economic arguments: the government has no business interfering with the free markets unless the markets are inherently incapable of addressing the issue on their own. Predatory monopolists and price fixing are two examples of such market failure where government intervention is needed. In the case of sub prime loans there has been no market failure. Yes, there were a lot of people, both lenders and borrowers, who made horrible financial decisions. However, those decisions are theirs to make and the consequences are theirs to bear.

In fact, if the government decides on some sort of sub-prime bail out, it will be undermining the markets. Healthy markets are built on the idea of risk and return. If a certain asset is risky, fewer investors are willing to invest in it, and therefore the return on that investment goes up. Thus, for sub-prime mortgages lenders demand a higher return in the form of a higher interest rate. Now, assume that the government bails out sub-prime lenders and / or borrowers. Such a move would tell the market that sub-prime loans are far less risky than they previously thought, and so both borrowers and lenders would be more inclined to get into these risky transactions. When investors do not properly understand the risks that they are accepting or think that someone else will bear any negative consequences, they enter into transactions that they would not otherwise pursue. If the government does not let investors and consumers get burned, it is setting us up for the next big financial bubble. Investors will think that the government will be there to bail them out again if the market goes south, thus they will be willing to pay more for risky assets and yet another financial bubble will emerge.

My bottom line: the government should let the sub-prime market fail. They should let the people who knowingly accepted unreasonable risks bear the burden of their mistakes. In the long run, this will only strengthen the markets. For once, Washington should do something it has been doing phenomenally well for many years: NOTHING.


Golbguru said...

I agree with " bailing out sub-prime borrowers the government would be rewarding financial recklessness."
I am not sure what kind of a message this type of bailing out will send. You don't want people to think "Oh I will buy that million dollar house...and if I can't afford it the government will do something about it."

broknowrchlatr said...

I agree 100%. Wy should people who make good financial decisions have to bail out the companies and individuals that do not.

When companies like CountryWide Home Loans started offereing their "SmartChoice" loans that basically gave a purchaser the option of whether to pay an interest-only payment or pay some principle down, I knew they were setting themselves up for failure. Then, they give such a loan to a sub-prime borrower and, who'd-a-thunk-it, the borrower defaults on the loan. If the lenders or the borrowers are really surprized by this, they need to get their heads checked.

Great discussion!

pfodyssey said...

Absolutely. I think this line of thinking should also include things like airline and car manufacturer bankruptcies, etc. It's profoundly stunning that our elected officials would promote such a solution. Only in a situation where we felt people were "conned" or "misled" would I see any such relief...and then, at the expense of those who were responsible for the misdeeds.

CarlMoeller said...

Wow, great post. I agree 100%. My favorite line of the whole post was at the end when you said "If the government does not let investors and consumers get burned, it is setting us up for the next big financial bubble"
This is something most investors just cannot fathom for some reason. Everyone thinks they are entitled to make money, no matter what they risk. And when it burns them cause they screwed up they go crying to uncle sam. Get back in the game you panzys!

R said...

I get really tired of having to keep track of all this stuff. But then I think, that's exactly what they want. Wear us out with real estate booms then busts, flunctuate the stock market, argue endlessly about healthcare versus taxes, worry us with war, pat us on the back with patriotism, warm our globe, and on and on and on it goes. Complain all you want but when the money wants to cover its back guess where it goes to get it. Gee, reminds of the good old savings and loan days.

KMC said...

I think you have to be very careful when condemning sub-prime borrowers who are now in trouble. While some are people who reached too far and/or gamed the system, some are simply regular people who, for any number or reasons, had to take a sub-prime loan to buy or keep their house.
Having said that, I obviously don't consider a bail-out advisable for the reasons you state.

Brad said...

It's not only the renters who get screwed. Homeowners who bought within their means will be subsidizing those bought more house than they can afford. Those who know how to prioritize and do without (renters and most homeowners) will help pay for assets and lifestyle improvemetns of those who made terrible decisions.

Anonymous said...

It further wreaks havoc with the capital markets. While many investment banks and funds have been funding this travesty by snapping up asset-backed backed securities of subprime mortgages, a number of others had correctly assessed the situation and are or were synthetically shorting the same securities in the derivatives markets. A bailout arbitrarily gives money from the former to the latter.

benstokesspam said...

Very easy to find senators contact info here

Anonymous said...

I'm an insider to the sub prime market and buy lots of failed debt.

The majority of these borrowers are minorities (specifically black) and on the lower end of middle income.

I fully expect politicians to hold a witch hunt looking for the "bad people" that gave these loans. As well I expect that whichever politicians pulls off the bailout or at least the appearance of a bailout will reap huge political rewards.

Stay tuned.... It should be interesting.

Anonymous said...

I agree with not giving us money but maybe extending the loan one more yr. I am in a sub prime loan and we have very good credit and our bills are always paid, but we are in the same boat as alot of people and we can't get refinanced because of the housing market. So what, we are left to forclose because nobody is buying houses? I just want one more yr. so we can see how the housing market goes and get a set rate, we aren't looking to default on our loan, or a way out, we want to keep our home and be finacially secure in our house.

Shadox said...

An extension on the loan is the equivilent of free money, and therefore I think that it is not the government's job to interfere with the free market. However, under the situation that you describe it would make sense for your lender to work with you to restructure the terms of your loan, rather than foreclose on you.

Such arrangements are completely acceptable and are even desirable, all I am saying is that the government should not get involved in such transactions.

Anonymous said...

"I just want one more yr. so we can see how the housing market goes and get a set rate, we aren't looking to default on our loan..."

Why should buying a house depend on which direction the market goes? It is for this same reason there should not be any bailout. Prices have to go down so that those who took the time to learn about the loan program and have saved money patiently should get their chance!

Anonymous said...

Very nice, with elections soon to come the chance of a potically driven bail out is increasing, and the poor renters and responsible homeowners will likely have to bear the price of this idiotic upcoming event.
Nonetheless, i hope this never happens. As far as dumb people who claim they were tricked into buying a 400k home for just 999.00 a month-well-@@-maybe they failed math. Caveat emptor Punks!!!!!!